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Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
Leszek Balcerowicz: Euro: problems and solutions
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Leszek Balcerowicz: Euro: problems and solutions

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Presentation by Dr. Leszek Balcerowicz, Warsaw School of Economics at University of Latvia …

Presentation by Dr. Leszek Balcerowicz, Warsaw School of Economics at University of Latvia
Riga, March 19, 2013.

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  • 1. Euro: problems and solutions* Leszek Balcerowicz Warsaw School of Economics March, 2013*I am grateful to Aleksander Łaszek and Marek Tatała for their assistance in preparingthis presentation.
  • 2. 1. Two types of crises which include the fiscal crises (SovereignDebt Distress) in the market economies A. The financial (banking) crisis fiscal crisis B. The fiscal crisis the financial (banking) crisis 2
  • 3. Figure 1. The dynamics of the Financial-Fiscal Crisis Inflated tax revenues Wrong policies Vs. The bust Inherant instability of the The fiscal Private sector markets? problems boom The recession The financial crisis 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Ireland 49,62% 54,79% 62,59% 72,70% 85,99% 94,41% 101,70% 112,55% 123,28% 118,89%Household loans to GDP Spain 48,14% 52,08% 57,61% 64,41% 71,87% 79,22% 83,24% 83,92% 86,43% 85,69% United Kingdom 74,89% 76,15% 82,73% 87,53% 92,55% 98,34% 92,81% 84,45% 103,68% 99,16% Ireland 60,6 64,9 74,1 82,4 88,5 100,5 100,0 90,9 78,5 66,3 Property price index Spain 47,0 54,4 64,0 75,2 85,6 94,6 100,0 100,7 93,2 89,6 United Kingdom 50,3 63,0 72,8 82,9 85,6 93,5 100,0 85,3 88,1 3 88,6 Source: Eurostat, ECB, Nationwide
  • 4. Policies which contribute to financial crises My reading of the empirical literature on the causes of the financial crises leads me to the following list of policies which contribute to the financial crises: 1. Politicized (or state-directed) credit allocation: it is usually driven by political considerations which dominate the economic risk assessment and, thus, leads to large banking losses and/or to Sovereign debt distress. The activity of Fannie May and Freddie Mac in the US is the recent example. 2. Persistently expansionary fiscal policy: it contributes to spending booms and may also result in the banking losses and in the public debt problems. 3. Monetary policy which occasionally leans “with the wind”, i.e. fuels asset bubbles (Fed’s policy in the 2000s being the main recent example). It has been linked to a doctrine of monetary policy which narrows its goal to the short-term CPJ inflation, and excludes from its purview asset price developments and the related factors (e.g. the growth of monetary and credit aggregates). 4. Tax regulations which favour debt financing relative to equity finance. 5. Subsidies to mortgage borrowing. 6. Financial regulations which encouraged excessive securitization, e.g. the risk-weights contained in Basel 1 and the mandatory use of credit rating by the financial investors. 7. Generous deposit insurance which eliminates an important source of market discipline. 8. Regulations which limit the shareholders concentration in large banks and thus increase the agency problems and weaken market discipline (Calomiris, 2009a). This may be an important source of the managers compensation schemes which favour short-term gains and disregard longer –term risks. 9. Policies which have resulted in the “too big to fail” syndrome, i.e. financial markets’ subsidization – vía reduced risk premiums – of the large financial conglomerates. This is another important instance of public interventions which weaken the market discipline. The resulting concentration, in the face of the financial crisis, exerts an enormous pressure upon the decision- makers to bail-out large financial companies again, thus creating a sort of a vicious circle. The policies in question included an easy acceptance of the mergers of already huge financial companies and an easy-money policy which fuelled the growth of already large financial conglomerates. 4
  • 5. Figure 2. The dynamics of Fiscal- Financial Crisis The systematic •The destructive overspanding political competition (welfare spending, The fiscal Problems in •Weak constraint on government problems financial sector the government consumption) sometimes sometimes Windfall gains Slow growth due to the worsening institutional system •Discovery of gas etc. (the Netherlands in the 1970s) •Falling employment and/or increasing structural unemployment •Lowering of the interest rates (Greece, Portugal, Spain, Italy) •Antimarket or anticompetitive regulations •Growing public sector 1990 1995 2000 2005 2006 2007 2008 2009 2010 General government total expenditure 43,43 43,17 46,64 44,60 45,21 47,61 50,60 53,81 50,20Greece General government net lending/borrowing -14,51 -6,99 -3,69 -5,64 -6,03 -6,80 -9,91 -15,56 -10,50 General government net debt 64,22 66,40 77,41 101,21 107,33 107,45 112,62 128,95 144,55 General government total expenditure 39,26 39,66 39,29 46,56 44,34 44,36 44,80 49,76 51,26Portugal General government net lending/borrowing -5,06 -3,41 -1,09 -6,49 -3,75 -3,21 -3,70 -10,17 -9,84 General government net debt n/a n/a 41,97 57,75 58,56 63,66 67,38 79,03 5 88,89 Source: IMF
  • 6. 2. Italy: high public debt and long-term economic stagnation in % of GDP in %140 10 8120 6100 480 260 0 -240 -420 -6 0 -8 1963 1971 1979 1987 1995 2003 2011 1961 1965 1967 1969 1973 1975 1977 1981 1983 1985 1989 1991 1993 1997 1999 2001 2005 2007 2009 Public debt (left scale) GDP per capita growth (right scale) Trend line (GDP growth) Sources: IMF and Ameco (2013)
  • 7. 3. Recent crises outside the eurozone
  • 8. GDP growth 2007-2012 (%)8 86 64 42 20 0 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012-2 -2-4 -4-6 -6-8 -8 Japan United Kingdom United States Canada Sweden Source: IMF WEO X 2012 8
  • 9. GG expenditures 2007-2012 (% of GDP)60 6050 5040 4030 3020 2010 10 0 0 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012 Japan United Kingdom United States Canada Sweden Source: IMF WEO X 2012 9
  • 10. GG deficits 2007-2012 (% of GDP) 4 4 2 2 0 0 -2 2007 2008 2009 2010 2011 2012 -2 2007 2008 2009 2010 2011 2012 -4 -4 -6 -6 -8 -8-10 -10-12 -12-14 -14-16 -16 Japan United Kingdom United States Canada Sweden Source: IMF WEO X 2012 10
  • 11. Gross public debt 2007-2012 (%)250 250200 200150 150100 100 50 50 0 0 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012 Japan United Kingdom United States Canada Sweden Source: IMF WEO X 2012 11
  • 12. 4. After the bubble: the follow up
  • 13. 1. The Official Crisis Lending (the bailouts) • IMF • European institutions 2. The Central Bank Purchases of the Government bonds • with no inflation (?) • with increased inflation 3. Repressed financial sector 4. The Outright Debt Reduction • unilateral • negotiated 5. Fiscal Consolidation (Reforms) • unsuccessful • successfulComments:• All bailouts create moral hazard; they do not solve the core problem; at the best they serve to buy time toprepare the consolidation/reform package (see the huge literature on IMF). Bailouts do not substitute forconsolidation/reforms.• The return to a repressed financial sector is –hopefully- not very likely•Appropriate fiscal consolidation/reforms can restore confidence of the financial markets, i.e. they have bothshort-term and loner-term effects (see later)•The popular expressions: „contagion”, „domino effects”, etc. are misleading metaphors• The uncritical use of those metaphors contributes to the pressure aiming at forcing the bailouts and centralbank „actions” 13• Delayed, insufficient and/or badly structured consolidation/reform effort exacerbate this pressure
  • 14. When deficit’s reduction is long lasting? First and foremost when it is expenditure based Authors Countries analyzed Period covered Main findingsAlesina, Perotti 20 OECD countries and 3 1960-1994 "We find that fiscal adjustments which rely primarily on spending cuts on transfers and the(1996) case studies government wage bill have a better chance of being successful (...) On the contrary fiscal (Denmark, Ireland and adjustments which rely primarily on tax increases and cuts in public investment tend not to Italy) last"McDermott, 20 OECD countries 1970-1995 "Fiscal consolidation that concentrates on the expenditure side, especially transfers andWestcott (1996) government wages, is more likely to succeed in reducing the public debt ratio than tax-based consolidation. Also, the greater the magnitude of the fiscal consolidation, the more likely it is to succeed in reducing the debt ratio"Alesina, Ardagna 20 OECD countries and 1960-1994(1998) 10 case studies "Three ingredients seem to be important for a succesful, long-lasting and expansionary fiscal adjustment. It must combine spending cuts in transfers, welfare programmes and the governemnt wage bill, some form of wage agreement with the unions that ensures wage moderation, and a devaluation immediately before the fiscal tightening"Alesina, Ardagna 21 OECD countries 1970-2007(2009) "As for fiscal adjustments those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases." 14
  • 15. Countries Period Authors analyzed covered Main findingsHagen von, 20 OECD 1960–1998Hallett, countriesStrauch "(...) the likelihood of sustained consolidation efforts rises when governments tackle politically sensitive items on the(2002) budget, such as transfers, subsidies, and government wages. Switching strategies that start with rising taxes and later switching to reduced spending does not produce better results than consistently expenditure-based consolidations. Our analysis also indicates that consolidation fatigue is an important element which policymakers should take into account, since they are strongly time-dependent. Finally, the economic conditions at the start of and during the fiscal consolidation matter. A high debt–GDP ratio and fiscal tightening in other OECD countries raise the likelihood of consolidations to persist. In addition, a weak but recovering domestic economy contributes to the longevity of consolidations."Guichard, 24 OECD 1978-2003Kennedy, countriesWurzel, André "Large initial deficits and high interest rates have been important in prompting fiscal adjustment and also in boosting the(2007) overall size and duration of consolidation. Concerning the quality of fiscal policies, an emphasis on cutting current expenditures has been associated with overall larger consolidation. Fiscal rules with embedded expenditure targets tended to be associated with larger and longer adjustments, pointing to institutional features playing a potentially important role in generating successful consolation efforts. Experience across countries also shows that certain design features such as transparency, flexibility to face shocks and effective enforcement mechanisms seem important for the effectiveness of fiscal rules"Barrios, EU27 and 8 1970-2008Langedijk, non EU OECDPench (2010) countries "(i) in presence of a systemic financial crisis, the repair of the banking sector is a pre-condition for a fiscal consolidation to succeed in reducing debt levels, especially so when fiscal consolidations are sharp (ii) even after the banking sector is repaired, fiscal consolidations are usually less successful than in absence of financial crises, although more vigorous fiscal consolidations (i.e. cold shower) tend to yield higher results (iii) current debt dynamics in the EU are very unfavourable and in some cases, coupled with rising debt servicing costs and much deteriorated growth outlook warranting differentiated consolidation strategies across EU countries (iv) We do not find conclusive evidence in support of exchange rates (including real exchange rate) depreciation/devaluation as enhancing the success of fiscal consolidation as their effect appear to be low and insignificant." 15
  • 16. Under certain conditions fiscal consolidation may turn out to beexpansionary. Theory indicates a number of channels through which fiscal adjustment may lead to such non-Keynesian effects Studies, in general, confirm that the non-Keynesian effects of fiscal consolidation are more likely to occur, when: • public debt before fiscal consolidation is high or fast growing rather than low and slowly growing; • fiscal consolidation is of large size and long lasting; • deficit is reduced through cuts in expenditure rather than via tax increases; • fiscal consolidation is focused on wages and salaries in public sector and on transfers to households; • fiscal consolidation is introduced in an open economy. 16
  • 17. Non- Keynesian effects Date ofAuthors publication Countries analysed Period covered Main findings "Our main results are: (i) fiscal policy changes can indeed have non-Keynesian effects if they are sufficiently large and protracted; (ii) these effects are present not only if the fiscal turnaround is obtained through 19 OECD changes in public consumption, but also if it is achieved through changes in taxes and transfers (...); (iii) countries and non-Keynesian effects work, at least partly, by affecting private sector expectations about the futureGiavazzi F., the case of income from labor and capital, and not solely via the implied changes in the real interest rate and assetPagano M. 1996 Sweden 1970-1992 values" "(…)fiscal consolidation need not trigger an economic slowdown, especially over the medium term. Fiscal consolidation that concentrates on the expenditure side, especially transfers and government wages, isMcDermott, 20 OECD more likely to succeed in reducing the public debt ratio than tax-based consolidation. Also, the greater theWestcott 1996 countries 1970-1995 magnitude of the fiscal consolidation, the more likely it is to succeed in reducing the debt ratio" "I find strong evidence that expenditure shocks have Keynesian effects at low levels of debt or deficit, and 19 OECD non-Keynesian effects in the opposite circumstances. The evidence on similar switch in the effects of taxPerotti R. 1999 countries 1965-1994 shocks is less strong." "A fiscal reform that takes the form of a reduction in wage government spending will crowd in an expansion in traded output and employment and improve the level of profitability. A reform that consists of an increase in labor taxation will have the opposite effect on the traded sector. (...) under flexible exchange rates, a reduction in wage government spending doubly improves profitability in theLane P. R., 14-17 OECD traded sector: not only do labor costs fall but firms in the traded sector also benefit from the inducedPerotti R. 2001 countries 1964-93 exchange rate depreciation." "The results confirm that composition of the consolidation determines the output response. Moreover, we find evidence that all types of fiscal consolidations stimulate private investments, while export acceleration is observed only when consolidations involve mostly expenditure curtailment. Private consumption reactionBorys P., to fiscal policy shows signs of nonlinearity - in the caseCizkowicz P., of minor adjustments Keynesian effects dominate, but they are cancelled out when sizable consolidationsRzooca A. 2011 10 NMS 1995-2010 are considered." 17
  • 18. 5. What are the structural problems in the euro area? What are the solutions? - Bail-outs cannot substitute for reforms but proper reforms produce both short-term and long-term benefits. 18
  • 19. Even a preliminary analysis shows, that the massive purchases of government bonds by the ECB would be a worse kind of a „bail-out”:• It would create a worse moral hazard problem (weakening the incentives to reform)• It would risk generating inflation and other negative consequences• It could undermine the trust in the ECB• It would give it a powerful political position inviting the pressures from the politicians• It would further undermine the rule of law in the EU in a situation when confidence is crucial 19
  • 20. Two kinds of problems:1. Not related to the essence of the EMU (eg. low capital/asset ratios in the largest European banks)2. Related to the essence of the EMU 20
  • 21. What are the special (inherent) problems of the EMU- the main assertions:1. One monetary policy can not fit all2. The monetary union without a „political” union 21
  • 22. One monetary policy can not fit all ? The nominal devaluation in necessary tool of adjustment?• The temporal aspect (assymetric shocks)- not a serious problems in view of the growing synchronization of the business cycles• The structural asepct: the ECB’s interest rate may be too low for some countries most of the time: boom bust; much more serious problem• The experience of hard pegs:PIIGS versus BELL 22
  • 23. GDP growth 2007-2012 (%)15 15 PIIGS BELL10 10 5 5 0 0 -5 -5-10 -10-15 -15-20 -20 Bulgaria Estonia Greece Ireland Italy Latvia Lithuania Portugal Spain Source: IMF WEO IV 2012 23
  • 24. 10 20 30 0 15 10 -5 0 5 JAN-2007 JAN-2007Source: ECB APR-2007 APR-2007 JUL-2007 JUL-2007 OCT-2007 OCT-2007 JAN-2008 JAN-2008 APR-2008 APR-2008 JUL-2008 Greece JUL-2008 OCT-2008 OCT-2008 JAN-2009 JAN-2009 APR-2009 Bulgaria APR-2009 Ireland JUL-2009 JUL-2009 OCT-2009 OCT-2009 PIIGS JAN-2010 BELL Italy JAN-2010 Latvia APR-2010 APR-2010 JUL-2010 JUL-2010 OCT-2010 OCT-2010 Portugal JAN-2011 Lithuania JAN-2011 APR-2011 APR-2011 10Y Bond yields spreads relative to Germany JUL-2011 JUL-2011 Spain OCT-2011 OCT-2011 JAN-2012 JAN-2012 APR-2012 APR-2012 JUL-2012 JUL-2012 OCT-2012 24 OCT-2012 JAN-2013 JAN-2013
  • 25. GDP per capita (peak = 100%)120% BELL 120% PIIGS110% 110%100% 100%90% 90%80% 80%70% 70%60% 60% 2012E 2013E 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013E 2004 2005 2006 2007 2008 2009 2010 2011 Bulgaria Estonia Latvia Lithuania Greece Ireland Italy Portugal Spain Source: IMF WEO X 2012 25
  • 26. Unemployment rate (%) 30 PIIGS30 BELL25 2520 2015 1510 105 50 0 Bulgaria Estonia Latvia Lithuania Greece Ireland Italy Portugal Spain Source: IMF WEO X 2012 26
  • 27. Current account balance (% GDP)10 BELL 10 PIIGS 5 0 0 2007 2008 2009 2010 2011 2012E 2013E 2007 2008 2009 2010 2011 2012E2013E -5 -10-10-15 -20-20-25 -30-30 Greece Ireland Italy Bulgaria Estonia Latvia Lithuania Portugal Spain Source: IMF WEO X 2012 27
  • 28. Unit Labor Costs (2007=100%)140 BELL (2007=100%) 140 PIIGS (2007=100%)130 130120 120110 110100 10090 90 2007 2008 2009 2010 2011 2007 2008 2009 2010 2011 Bulgaria Estonia Lithuania Latvia Greece Ireland Italy Portugal Spain Source: ECB SDW 28

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